Mortgage Fraud – Lenders Beware

In the recent decision of CIBC Mortgages Inc. v. Computershare Trust Co. of Canada, Justice Murray of the Ontario Superior Court of Justice decided a priority dispute between three innocent mortgagees, all of whom were the victims of a fraud committed by the mortgagors. In reaching his decision, Justice Murray not only interpreted the relevant sections of the Land Titles Act (“LTA”) relating to fraudulent instruments, but also relied upon the decision of Lawrence v Maple Trust Company, 84 O.R. (3d) 94 (“Lawrence”), and the theory of deferred indefeasibility (the “Theory”). Consequently, the decision will undoubtedly have a significant impact in the area of real estate law as it relates to mortgage fraud and the responsibilities of mortgagees to be cognizant of red flags of fraud when lending money to mortgagors.

The Facts

On November 21, 2008, Computershare loaned $280,801.95 to the mortgagors and secured its interest in the land by registering a charge on the property (the “Computershare Mortgage”).

On August 26, 2009, slightly under a year after the Computershare Mortgage was registered on title, it was discharged without Computershare’s knowledge (the “Discharge”) by unknown individuals who did not possess Computershare’s authority to register any discharge. However, despite the Discharge, the mortgagors continued making mortgage payments to Computershare until January, 2013, at which time the mortgagors’ fraudulent actions were discovered.

Subsequent to the Computershare Mortgage being discharged, the mortgagors obtained a private loan which was secured by a purported “first charge” on the property (the “Private Mortgage”). After obtaining the private loan, the mortgagors then applied for and obtained two additional loans from CIBC and Secure Capital. Although the mortgagors were making payments to Computershare at the time of their loan applications to the private mortgagee, CIBC and Secure Capital, and therefore understood that Computershare was the rightful first mortgagee on the property, the mortgagors concealed this fact from all three parties.

After CIBC and Secure Capital advanced their respective loans, from which the mortgagors used the proceeds to pay off the Private Mortgage, there should have been three mortgages registered on title, being Computershare’s, CIBC’s and Secure Capital’s. However, as a result of the Discharge, only CIBC’s and Secure Capital’s charges appeared on title.

In January 2013, when the mortgagors defaulted on the Computershare Mortgage, as well as the CIBC and Secure Capital mortgages, Computershare discovered the Discharge and filed an application to, inter alia, have the Computershare Mortgage restored as a first charge on title to the property.

Fraudulent Persons and Fraudulent Instruments

There was no doubt as to whether the Discharge was a fraudulent instrument. However, in order to settle the priority dispute between the mortgagees, Justice Murray was required to determine whether the CIBC and Secure Capital mortgages were also fraudulent instruments. If the CIBC and Secure Capital mortgages were not fraudulent instruments, then pursuant to section 78(4) of the LTA they would have been ranked first and second respectively in terms of priority. On the other hand, if it was found that the CIBC and Secure Capital mortgages were both fraudulent instruments, then in accordance with sections 78(4.1) and 78(4.2) of the LTA, the Computershare Mortgage would have been restored as a first charge.

Upon considering the evidence before him, Justice Murray determined that the CIBC and Secure Capital mortgages were indeed fraudulent instruments as defined in the LTA. Although CIBC and Secure Capital argued otherwise, Justice Murray found that the mortgagors were fraudulent persons pursuant to subsection (c) of the definition for “fraudulent person”. The mortgagors were not the owners of the “interest in land” that they conveyed to CIBC and Secure Capital. Instead, the mortgagors had fraudulently discharged the Computershare Mortgage and conveyed to themselves the interest in the property that they knew rightfully belonged to Computershare. The mortgagors then proceeded to transfer the fraudulently obtained interest in the property to CIBC and Secure Capital, which in turn led to Justice Murray’s conclusion that the CIBC and Secure Capital mortgages were fraudulent instruments as the definition of “fraudulent instrument” includes instruments that a fraudulent person purports to transfer to another.

Theory of Deferred Indefeasibility

Pursuant to the Theory, which provides guidance as to how the LTA is to be interpreted, fraudsters are prohibited from taking good title or interest in land as a result of their fraudulent actions. As fraudsters cannot obtain good title or interest, they cannot become true owners and therefore cannot transfer good title or interest in land that is fraudulently obtained to any other party. In turn, in accordance with the Theory and the LTA, although CIBC and Secure Capital did not act in bad faith, their respective mortgage interests in the property were found to be subordinate to that of Computershare’s as they took their respective interests directly from fraudsters who never had a valid interest to convey.

Similar to the Lawrence case, just as Maple Trust, which had taken an invalid mortgage from a fraudster, was found to be the intermediate owner and therefore susceptible to a claim from the true owner of the property, CIBC and Secure Capital were considered the intermediate owners in this situation. Each of CIBC and Secure Capital had an opportunity to avoid the fraud as they were dealing directly with the fraudsters but failed to do so, and instead each took an invalid interest in the property. Therefore, CIBC’s and Secure Capital’s respective interests were vulnerable to that of Computershare’s, who was in a position akin to that of a true owner that was fraudulently deprived of its interest in the property.

The Takeaway

After the Lawrence case was decided, there was some uncertainty as to whether innocent mortgagees who have fraudulently lost their interest in a property could rely on the Theory in the same manner as home owners could. Justice Murray’s decision makes it clear that the Theory applies equally to situations involving mortgagees who have fraudulently lost an interest in a property as it does to situations where home owners have been victimized.

This decision also serves as a stark reminder to mortgagees that while they may not be required to investigate the entire history of past dealings with respect to a particular piece of land, they are nonetheless responsible for conducting thorough due diligence when engaging in lending transactions. While the mirror and curtain principles, along with the insurance principle, remain the pillars of the land titles system, mortgagees cannot simply use their reliance on the register as a mechanism by which to absolve themselves of liability in circumstances where they have received an interest in land from a fraudster. If a mortgagee is dealing with a fraudster who has defrauded a home owner or a previous mortgagee, that mortgagee has the last and best opportunity to avoid the fraud, and if it does not do so it will ultimately bear the consequences associated with being an intermediate owner. Therefore, mortgagees may need to take additional precautions in order to ensure that they are receiving valid charges from mortgagors, and it is imperative that they, and not just their lawyers, be cognizant of red flags of fraud when engaging in loan transactions.